Numbers finally start to add up as operators go back to basics

Colin Kruger

WHEN ABC Learning began its meteoric rise nearly a decade ago the question raised by many community childcare operators struggling to break even was simple: how could this corporate leviathan make any money, let alone the fantastic figures it was reporting?

For hapless ABC Learning insiders, the question was: how could it not?

''This is a business subsidised by government - how can it be unprofitable?'' wailed ABC Learning's former chairwoman, Sallyanne Atkinson, soon after the collapse.

A submission to the Senate childcare inquiry highlighted the big discrepancy between ABC's success story and the brutal financial reality of child care. Steve Trzcinski, a business executive who for many years had been involved with his daughter's community childcare centre in the northern suburbs of Adelaide, could not make the numbers stack up.

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''The main cause for my concern was my understanding that my service operated with staffing costs typically at 80 per cent to 90 per cent of operating revenues, and without the need to pay rent, but with a similar fee structure to that of ABC Learning, we were barely able to generate a surplus, whereas ABC Learning were somehow able to generate operating 'profits from ordinary activities' of 30 per cent to over 40 per cent,'' he told the inquiry. ''This was a huge discrepancy and it caused me much concern.''

The demise of ABC Learning and other listed childcare operators appeared to give a definitive answer on whether profit and child care could mix despite government subsidies which will breach the $4 billion mark this year.

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So it may come as a surprise that most childcare centres are still run under a ''for-profit'' business model.

In fact, there is already a new corporate player emulating ABC Learning's early years with a voracious appetite for other childcare operations and international expansion. This was not part of the script when community non-profit operators lined up at the Senate inquiry.

KU Children's Services, the largest non-commercial childcare company in Australia until ABC Learning's carcass was sold to Goodstart last year, said the ABC disaster proved the ''emperor has no clothes''.

''Childcare is not a licence to print money and any profits on the scale being reported to be made by ABC were not due to the provision of child care.''

This is true. The scale of profits reported by ABC Learning is now accepted to be a product of questionable accounting practices. And the financial performance of the profitable centres sold to Goodstart does not provide much cause for optimism either.

An abbreviated financial account showed the operations barely broke even in May last year.

Robin Crawford, the chairman of Goodstart, warned against reading too much into the numbers and says the business is on track to generate more than $40 million in earnings before interest, tax, depreciation and amortisation for the current financial year.

''A year in the childcare business varies enormously. We bought well and are tracking pretty much as expected,'' he says.

The figures look less rosy when you consider it does not take into account an annualised interest bill of $12 million, and the numbers rely on Goodstart's charity exemption from payroll tax reportedly worth $20 million a year.

No wonder these 650 ''profitable'' childcare centres fetched just $103 million last year. This was the core of the ABC Learning empire which was valued in the billions at its peak.

And if these are the profitable centres, how are the less viable ABC Learning centres faring.

Not well, appears to be the answer for one of those centres in Griffith NSW, Kindaroo childcare centre, which closed just weeks before Christmas.

But to focus on these examples ignores the fact that most child care in Australia remains in private hands - just a very different set of hands from what we're used to reading about.

A report from the Office of Early Childhood Education and Child Care last year showed that, even after transferring 650 ABC Learning centres to the non-profit sector, about 64 per cent of childcare centres remained in private hands.

With the collapse of the corporate sector ''the major shareholders are mums and dads'', says John Wall, an executive with the childcare management services firm Total Childcare Solutions.

While not offering a simple answer for what keeps these small operators in business, Wall - an industry veteran at both the corporate and small operator level - says these owner operators work a lot harder at the centre level than a company that owns 1500 centres.

But they also scrimp a little, according to the non-profit sector, which points to research showing it offers higher quality care - at an inevitable cost.

''Generally the not-for-profit model is more expensive than the ABC model due to such things as the higher quality of care (including higher staff to child ratios and better qualifications and experience) and the inclusion of children with additional needs'', KU said in its submission.

While it has no real beef with small private providers KU says there is no place for large, corporatised operations due to ''conflicting priorities'' which put investor interests first.

KU did not want to comment on the state of the industry with corporate child care providers on the ascendancy again.

But the relative calm since the collapse of ABC Learning appears to have benefited the childcare survivors by killing off the irrational exuberance that came with corporate expansion.

As Wall explains it, the collapse of ABC Learning and its predecessors means there isn't the ''saturation events'' of the past.

''Saturation events'' refer to the sudden increase in childcare capacity that would accompany corporate expansion. If you were in an expansion area where new operators were fighting for market share - and kids were crawling out the door to the competition - the effect could be catastrophic.

With a high fixed-cost base, occupancy levels are the make or break for all childcare centres, whether corporate or community.

An industry report from the market researcher IBISWorld estimates that long day-care centres require occupancy rates of at least 70 per cent to be profitable.

In what may be a telling tale of how hard ABC Learning had to run to stay afloat, the company's founder, Eddy Groves, reportedly told institutional investors that 90 per cent occupancy was the magic metric for the company.

Anything above this level meant the company would be making good money, anything less than this, the company would struggle, he said.

Some analysts were rightly concerned when ABC Learning stopped reporting its occupancy levels well ahead of its collapse in 2008. But the subsequent rationalisation of its operations appears to have done much to improve the occupancy - and viability - of the remaining market participants.

Wall says average occupancy levels are up about 2 per cent across the centres he is involved with, which translates to a $15,000 to $20,000 increase in the bottom line each year.

''All our owners [have done] exceptionally well in 2010,'' he says.

The saturation theory is also supported by the Office of Early Childhood report.

''In many locations, ABC Learning's growth appears to have created an oversupply in long day care provision. There is considerable scope for occupancy of the remaining centres to grow,'' the report says.

It notes that ''the amount of long day care used as a proportion of total hours available was 75 per cent in September 2009'' - comfortably above the Ibis estimate of 70 per cent as a break-even point.

The figures provide some hope that corporates can survive in the childcare game which is just as well - the experiment with corporate child care is not over.

THE ASX-listed G8 Education - the result of a merger last year between the publicly listed straggler Early Learning Services (ELS) and the privately owned Payce - has embarked on an acquisition spree reminiscent of ABC Learning in its formative years. In November G8 said it owned 119 centres in Australia and managed another 21. In Singapore it owns 18 and manages a further 48.

The company has forecast revenues of $115 million for the current year and earnings before interest and tax of $17 million, but the pace of growth means it is hard to track how much growth is being internally generated and how much is being acquired.

This was also a problem at ABC Learning.

But G8's chief executive, Craig Chapman, says the company has avoided ABC Learning's excesses such as overpaying for the centres it acquires and using its shares - not debt - to pay for them.

''We've bought on the right multiples,'' Chapman says. ''We had evidence ABC was paying up to 78 times EBIT [earnings before interest and tax].''

Chapman is not shy about naming some of the important factors which allow profit-driven centres to thrive. He says having well-maintained centres and a strong education curriculum are crucial.

''With these factors you can charge a higher price,'' he says.

And with occupancy such a crucial factor, advertising is also important to make sure the centres are kept full.

Another important difference is that profit-oriented operators like G8 choose their markets carefully.

''Location is critical and the demographics around that location are definitely important,'' he says.

The company has not been shy about offering detailed numbers on how its profit engine works.

A recent market update reports G8's occupancy levels average about 80 per cent in Australia and 90 per cent in Singapore.

Breaking down the numbers, G8 says that Australia's 80 per cent occupancy levels gives it an EBIT margin of 18 per cent. Revenues per centre average $1 million.

Employee costs account for 60 per cent of the centres' revenues, with rent using another 12 per cent.

By comparison, KU's annual report for the year ending December 31, 2009, showed more than 83 per cent of revenues were paid out in staff costs.

While G8's ascendancy has not attracted any controversy to date the same cannot be said for all of its principals.

Its chairwoman, Jenny Hutson, and the managing director, Chris Scott, have a close relationship going back to the days of the travel group S8, which was acquired by MFS - the Gold Coast financier which subsequently imploded amid allegations of fraud.

In early 2008, Hutson had successfully lobbied for Scott and his associates to become directors of MFS and was later formally appointed as an adviser to the board.

One of those associates was G8's chief executive, Chapman.

The dealings of previous management meant the collapse of MFS was all but inevitable by the time the trio came on board, but controversial deals were still being done.

This includes Hutson's Wellington Capital being appointed the lucrative role of managing MFS's troubled Premium Income Fund - a position it holds to this day despite questions over whether the transaction was handled at arm's length given Hutson's closeness to the board.

In September last year, the insolvency specialist Mark Korda told a public examination of the collapse of MFS that the decision to appoint Wellington Capital as manager was the ''lesser of all the evils we could have done''.

''At the time of the transaction I don't think they were independent,'' Korda said at the examination.

Neither Hutson - who has publicly denied any conflict - nor Chapman and Scott have been accused of any wrongdoing in relation to the collapse.

Wall, who was previously involved with G8's earlier incarnation, ELS, sees nothing controversial in the trio's latest venture which, he says, is attempting to be an alternative to the ABC Learning model.

''They are going to have to work very, very hard to get the same return as mum and dad operations,'' he says, but adds there's no reason large players like G8 and Goodstart can't emulate their small-scale counterparts.

''They obviously need to understand and analyse what parents and the community want from there centre,'' he says.

Despite getting badly burnt by ABC Learning and other collapses, the financial market is looking favourably on G8 which has doubled its share price since emerging from the ELS listing in March last year and has strong backing from institutional shareholders.

Three such investors own about 40 per cent of the company's stock.

As for GoodStart, Wall says he is seeing a greater desire from the company to make each centre more community based and ''if so I believe they will be much more profitable and for the right reasons''.

After ABC Learning's debacle as a for-profit listed company, many parties are certainly hoping so.